Spoiler alert: All investments carry some degree of risk, including the latest currency to take the financial world by storm: cryptocurrency – also known as crypto.
Articles and online forums are loaded with whiplash-inducing news of crypto billionaires alongside reports warning us of a crypto crash. It can be difficult to decide whether to invest in crypto.
If you are already investing in crypto, you may be wondering what you can do with it besides spend it or trade it.
Well, here’s an idea: If you need cash fast, you can use your crypto as collateral for a loan (also known as a crypto-backed loan). But using cryptocurrency to get a loan has advantages, disadvantages – and significant risks.
We can help you understand the potential risks and benefits of crypto loans. Then you can decide if you are financially prepared to take out a crypto loan.
But first, let’s chat about crypto.
What Is Cryptocurrency?
Cryptocurrency is digital currency that uses electronic tokens that are not backed by financial institutions or governments.
You can’t hold cryptocurrency in your hand; it exists virtually. The currency and its transactions are secured by a series of algorithms known as cryptography. Cryptography makes it almost impossible to counterfeit cryptocurrency or spend it multiple times.
Most conventional currency is created and issued by governments. You would recognize it as the physical money – think: dollar, euro, peso, yen, etc. – that’s in circulation where you live. In the U.S., the conventional currency, also known as fiat currency, is the dollar. The value of the dollar is based on the creditworthiness of the U.S. government.
Cryptocurrencies are not created by governments. They are based on decentralized digital networks spread across multiple computers using blockchain technology.
What is crypto used for?
Cryptocurrency can be spent like conventional currency. A merchant just has to accept crypto payments.
Crypto is mostly used as a trading instrument like stocks or bonds. People purchase crypto expecting (or hoping) it will increase in value. Then they can turn around and sell it for a profit.
But the market value of crypto tends to be volatile.
Depending on the type of crypto (bitcoin, ethereum or ripple), the cost of each coin or token can range from a fraction of a cent to tens of thousands of dollars. And each can gain or lose a huge percentage of its value very quickly. This makes investing in crypto very risky.
How do you purchase crypto?
You can buy crypto with a fiat currency (traditional money) or by trading another cryptocurrency on an exchange such as Coinbase, Binance or Gemini.
Crypto is created and can be earned by mining it. You mine crypto using a computer or special hardware and software to solve a complex mathematical problem. The process is expensive, uses a lot of energy and often takes a long time. However, mining cryptocurrency is usually very profitable.
What Is Crypto Lending and How Does It Work?
Crypto loans, which are secured loans that require collateral, allow crypto owners to get cash without selling their crypto. Like a house secures a home loan and a car secures an auto loan, cryptocurrency acts as collateral to secure a crypto loan. Defaulting on the loan can mean losing your collateral.
Crypto loans are installment loans (think: personal loans). You borrow money and pay it back (plus interest) in monthly installments, usually in 12 months or less. This means you don’t have a lot of time to pay back the loan.
Crypto loans typically have lower interest rates than credit cards and unsecured personal loans, though the interest rate will depend on the lender.
Because crypto loans are nontraditional, most crypto loans are offered by nontraditional lenders, usually a crypto-lending platform like Celsius or BlockFi.
What Are the Categories of Crypto Loans?
There are two categories of crypto loans:
CeFi loans are custodial loans. A third party has custody and control of the collateralized crypto. The borrower (also known as the asset holder) can’t access the crypto.
DeFi loans are noncustodial loans. The crypto isn’t controlled by a third party. The crypto owner retains control of their crypto unless they default on the loan.
What Do You Need To Take Out a Crypto Loan?
Before you can take out a crypto loan, you need to know how much crypto you can put up as collateral and the value of your crypto. There’s typically no credit check required. And depending on the lender, getting a crypto loan may not include many of the steps required to take out a secured personal loan.
Crypto assets needed
You can usually borrow up to 50% of your crypto portfolio’s value, though some lenders might even allow you to borrow up to 90%.
In general, you’ll need quite a bit of coin to get a crypto loan. The standard minimum loan amount is $10,000. But some crypto lenders will approve loan amounts as low as $500.
Most lenders will require at least $20,000 in crypto holdings to secure a $10,000 loan.
Why Not Sell Crypto Instead?
If a crypto investor needs cash, why not sell their crypto instead of taking out a crypto loan? Well, there are several reasons why a crypto loan might be preferable:
To take advantage of increases in value
Taking out a crypto loan might make sense if you need cash but plan to hold on to your crypto for a long time. If you expect the value of your crypto to go up, you might want to hang on to it and potentially make more money when you sell it.
To avoid taxes
Selling crypto too soon after purchasing it can trigger capital gains tax. You may wish to avoid paying capital gains tax by waiting before selling your crypto.
Pros and Cons of Crypto Loans
Crypto loans have benefits and drawbacks. And depending on your risk tolerance, some of the drawbacks may be minor inconveniences or major problems. Here are some of the main pros and cons of crypto loans:
PROS of Crypto Loans👍
Sometimes you can get money in a few hours.
You can keep your crypto while you borrow against it.
Crypto loan interest rates are generally lower than secured personal loan rates.
CONS of Crypto Loans👎
If the value of the crypto you’re using as collateral falls below a certain level, your lender can make a margin call, requiring more collateral to maintain the value of the loan.
Since you can’t sell your collateralized assets because you can’t access them, you might miss the chance to profit from spikes in your crypto’s value.
Because crypto loan terms typically last for 12 months or less, the monthly payments can be high.
How Are Crypto Loans Taxed?
In most cases, crypto loans are not taxed. Using crypto as collateral is not a taxable event. However, crypto is considered a capital asset or property. Like any property, crypto isn’t taxed until you sell it.
If your crypto is sold at a profit, you may incur capital gains tax. That rule applies to the sale of any capital asset. Of course, you may also be able to deduct losses from your taxes.
What Are Alternatives to Borrowing Against Your Crypto?
Good credit can present alternatives to getting a cryptocurrency loan. Here are some common options:
Home equity loan or HELOC
If you’re a homeowner, consider taking out a home equity loan or home equity line of credit (HELOC). What you can borrow will depend on how much equity you have. In general, you can borrow up to 85% of the equity in your home.
There are two key differences between a home equity loan and a HELOC:
- With a home equity loan, you get an upfront, lump-sum payment you pay back in monthly installments at a fixed interest rate.
- A HELOC offers a line of revolving credit. You only pay interest on what you borrow up to your total loan amount. Most HELOCs have variable interest rates, so what you pay every month could go up or down over the loan’s term.
Home equity loan and HELOC interest rates are usually around 2% – 8%. Your interest rate will depend on your lender and the going prime interest rate. It usually takes an average of 2 – 6 weeks to receive your money.
Personal loans come in two varieties: secured (requires collateral) or unsecured (no collateral required). A secured loan usually has a lower interest rate than an unsecured loan. But interest rates will vary depending on your creditworthiness and the type of personal loan you choose. Rates can range between 5% and 36%. In most cases, you can typically borrow $3,000 – $50,000 and get the funds relatively quickly, anything from a few days to 24 hours.
Crypto Loans: You’ve Got Options
Like Coney Island’s world-famous Cyclone roller coaster, investing in cryptocurrency can be an exciting ride. And unless the latest headlines are wrong, crypto is volatile and a high-risk investment. Taking out a crypto loan might tack on even more risk, but it may be worthwhile if you need cash in a hurry. If you have good credit, there are alternatives you can explore.
ExperianTM. “What is Crypto Lending and How Does it Work?” Retrieved June 2022 from https://www.experian.com/blogs/ask-experian/what-is-crypto-lending/
Cision/PR Newswire. “Celsius lowers crypto loan minimums to $500, pre-approves its 200,000 customers.” Retrieved June 2022 from https://www.prnewswire.com/news-releases/celsius-lowers-crypto-loan-minimums-to-500–pre-approves-its-200-000-customers-301157066.html